The Summer Rally Will Roll On—For Now

07/27/2010 12:30 pm EST

Focus: MARKETS

Mark Leibovit

Chief Market Strategist, VRTrader.com

Mark Leibovit, editor of VRTrader.com, says the markets will continue to move up for a while, but watch out when summer turns to fall.

That stock market rallied Friday afternoon after the Committee of European Banking Supervisors announced that just seven of 91 European banks failed its stress test—five of them in Spain, one in Greece, and one in Germany.

The Dow Jones Industrial Average rallied 102.32 to 10,424.62; the Standard & Poor’s 500 index gained 1102.66 to 8.99, and the Nasdaq Composite index rose 23.58 to 2269.47. Breadth was positive, and volume was good.

The Friday afternoon rally was a fitting end to a week in which the markets rallied, and the indexes broke through some of the initial resistance levels (SPX 1,100). The odds favor a rally into August, but this rally has lots of overhead resistance (SPX 1,113.40 representing the 200-day moving average and 1,131.23 from the June high) and should be seen as a bear market rally and a good opportunity to go short at the appropriate time.

The door is now open to 1,120-1,130 and perhaps 1,160-1,180. If volume turns south before then, so be it. Overall, I have written that a July/August rally was cyclically in the stars, but it will be a prelude to the next market washout, which could easily result in new lows (under the July 1st 1,010 low in the S&P 500, with potential into the mid-900s).

Although most investors apparently interpreted this past week's earnings reports as indications that the US economy and corporate operating results will continue to improve during the months ahead, a closer review of earnings reports paint somewhat of a different picture. It's called “smoke and mirrors.”

Another word of caution: Earnings results last week were strong, but top-line growth has been largely absent. The better-than-expected earnings have largely been the result of cost cutting. The economy was recovering from very depressed levels in quarters one and two which helped companies beat expectations. But now these companies will have to beat raised expectations at a time when the economy may be weakening again.

Having said all the above, the FTSE in London, the Nasdaq Composite, and the Dow Jones Transportation Average (all leading indexes) are now trading above their respective 200-day moving averages. This is bullish unless they break back under.

We're trading above both the 50-day and 200-day moving average. A “key reversal” pattern to the up side set the bullish tone [last] Tuesday. With the Dow Transports in an up trend, I have to lean more to the bull side short term, especially as the Transports have been such an important leading and coincident barometer to market action over the years. It may only be a bear market bounce, but until it reverses, I wouldn't want to fight the tape.

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